China’s “ghost cities” may be a lot less ghostly than previously thought.

The phenomenon of eerie shopping malls and completed apartment blocks completely devoid of stirrings of Chinese life has been well-documented in Western media in recent years, from video segments to photo series and more.

But according to CLSA analyst Nicole Wong, those reports might be missing the forest for the trees””or in this case, missing the people for their timing. Ms. Wong, who recently returned from a tour of 137 projects in three Chinese cities often cited for their ghostly developments, says that the presence of empty apartments is thanks to some unusual quirks of China’s real-estate landscape.

Specifically, she noted at Tuesday’s CLSA Asia-Pacific Markets Investors’ Forum in Hong Kong, new Chinese apartments are typically sold as virtual concrete shells that buyers must outfit, installing everything from showers to flooring to kitchen sinks to make them move-in ready. Accordingly, Ms. Wong notes, many such “ghost” developments take awhile to gain traction””especially as it’s often the sale of the land they’re sitting on that allows the city to fund subsequent facilities and transportation links that will eventually help make them mature neighborhoods.

“When buildings are first completed they are actually not that habitable, so it takes a long time before most people want to move in,” Ms. Wong said.

In a report on her findings, Ms. Wong notes that buildings completed between 2008-11 in Zhengzhou, Ordos and Wenzhou“”often cited as instances of an overly frothy property market””have typically seen tenants move in over a three-year period. Among such buildings, Ms. Wong’s survey found an average of 48% take-up in the first 12-18 months, another 19% in the next year, and then yet another 15% in the year after that. Such a delay, she says, can be attributed to the fact that residents need time not only to fully outfit their units, but many also like to wait until their neighbors have done so as well to avoid moving in before the dust clouds and drilling sounds have subsided.

In the case of Henan’s Zhengzhou””frequently dubbed China’s “largest ghost city”””Ms. Wong notes that a number of media portrayals of the city’s newer areas have used photographs taken between 2010-12, before the metro system connecting the district to the city’s more established neighborhoods was completed. On her most recent visit there in August, Ms. Wong said she saw many cars, “hordes of pedestrians” and considerable ground activity in addition to curtains and air-conditioners installed in numerous residential buildings.

“I asked local people about what they think…about Zhengzhou being a ghost city and the answer is, ‘What?’ They don’t actually have any idea they’re being labeled a ghost city,” Ms. Wong said.

But Ms. Wong also goes on to suggest where the real problems lie:

Still, while the spectral quality of some “ghost cities” may be fleeting, other white-elephant developments built in cities with smaller populations, such as northeastern Tieling or Inner Mongolia’s Ordos, are likely to continue struggling. For example, the deflation of Ordos’s coal mining industry has further hurt the city’s ability to draw new residents, Ms. Wong notes, spurring vacancy rates as high as 37% in certain neighborhoods, a trend CLSA expects to deepen. Some property developers have suspended work, while others have simply fled.

I see an analogy to the US financial crisis. Both liberals and conservatives missed the real problem. It wasn’t the big banks, it was the way FDIC encouraged small banks to make risky loans to developers. The US taxpayers were saddled with the bill. This WSJ article suggests that in China the real problem is in the smaller cities, which are not seeing the population growth of the big cities:

Still, relatively low government debt, which the IMF recently estimated at 45% of GDP, means China still has scope to backstop any sharp slide in growth or prop up the financial system, if required. But to avoid the mistakes made after 2008, Beijing would need to figure out how to target its infusions of money into underfunded parts of the economy to produce a long-term payoff.

One can see the byproducts of the previous big stimulus program everywhere, from ghost towns of big unoccupied housing projects on the outskirts of many Chinese cities, to unfinished infrastructure and factories.

GK Dragonomics, a Beijing research firm, says much of China’s housing investment since 2008 has been directed at smaller cities where population growth is ebbing and not toward large cities where population is rising. The result: housing shortages in Beijing, Shanghai and other large cities, driving up home prices, while there are housing gluts in hundreds of others.

In other East Asian countries you are seeing a striking concentration of population in the urban centers. Tokyo is far and away the largest city in the world. Greater Seoul is third, and has 1/2 of Korea’s 50 million people. I’d guess that the Chinese will tend to migrate toward the Beijing/Tianjin, Shanghai, and Pearl River delta areas. One again, the WSJ:

SHANGHAI””Pundits once mocked Shanghai’s Pudong district, a purpose-built version of Manhattan, as overdesigned and underoccupied, evidence in steel and glass of a property bubble of historic proportions.

Deng Xiaoping sparked the transformation of Pudong’s riverfront of warehouses with a 1990 utterance: “Shanghai is our trump card.” A decade later, Pudong was Exhibit A for critics of an urban-development model guided by state planners, a soulless district where 70% of the buildings stood empty. Visiting economist Milton Friedman called it “a statist monument for a dead pharaoh on the level of the pyramids.”

Today, as worries of a Chinese property crash are back in force, there is an unlikely bright spot: Pudong.

The district’s transformation into a vibrant nexus for finance, trade and entertainment is testament to factors like the strong momentum of Chinese migration toward urban centers.

Again, the real problem is the smaller Chinese cities. The big cities can use almost everything being built, and more. The problem is that smaller cities are building subways, airports, city halls, etc that are far too lavish for their needs. It’s not clear than many people will want to live in these smaller cities. And the cause of the problem is exactly the same as with our smaller banks—moral hazard. Large banks have such diversified portfolios that the incentive to gamble is much lower. At a bigger bank a $1 billion gamble is more likely to come out of the hide of shareholders. At smaller banks a gamble that goes bad might well be picked up by taxpayers. In much the same way the smaller Chinese cities expect to get bailed out by Beijing.

This comment links to some videos made by a guy who recently visited some of the more famous Chinese “ghost cities. The reality is mixed.

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What about the moral hazard between the US Treasury and the central bank? The Treasury can finance any cockamamie project and never worry about actually nominally defaulting.

With a free market in money, which would likely be something other than paper or digital entries than can be created at virtually no cost, this moral hazard would be eliminated.

What about the moral hazard between the big US banks and the Fed? The Greenspan put? If the banks fail, then the Fed will bail them out, and the Fed can present its bailout as “stabilizing the price level”, and you can believe it is “stabilizing NGDP”.

But let’s not actually want to solve moral hazards. Let us only be concerned with particular moral hazards, while the white elephant moral hazards are ignored for one’s own intellectual investment incentive reasons.

Although China is often thought of as a monolithic state, it is still a developing country with poor institutions and ineffective oversight. If anything, the central government is too small and too weak to control what happens in the provinces.

China doesn’t need to de-regulate; it needs to regulate. And there should be a lesson in that for small-government conservatives who think that less is always more when it comes to regulation. If anything, the progression from developing to developed nation is characterised by the establishment of an effective system of regulation, oversight and enforcement.

Some China developments, too far from transit or city centers, will stay empty. You cannot plop a mall or apartment complex in the middle of nowhere and expect it to work.

But China is lucky otherwise—it is on that part of the macroeconomic growth curve in which sins are forgiven by smartly rising aggregate demand. Even so-so developments will do okay. Like opening up a furniture store, or building an apartment building, in the 1960s in Los Angeles. Hard to miss.

The trick is to have smartly rising aggregate demand—think monetary policy. China has an aggressive pro-growth monetary policy.

It would be nice if economists suggested we try boom times again in America.

Oblivia, China needs a far, far smaller system of government, combined with a more effective system of oversight. Privatizing the SOEs would help, as they are doing the vast majority of the wasteful investment.

Zac, Yes, I have seen that. It’s a bit messy as there are actually two MOAs. I believe wages are denominated in terms of the MOE, and wages are the key variable.

From personal experience I can attest that I have been literally all over Beijing(well most of Beijing) without seeing any empty residential complexes that had been completed, there is huge demand for housing in big cities and it never made sense to me that there would be lots of unused real estate, though even native Chinese believe the silly statistics the media reports over and over again. It is also very true that apartments basically start as large uninhabitable concrete holes. That said, if I had a dollar for every giant mall that appears empty at all times of day or with people who browse but never shop, I would have an additional 4 dollars at least. Though the argument could be made that such malls are being constructed for the future, not for the present, but the amount of government “assistance” for such projects still makes me at least a little skeptical that they are a particularly good use of resources.

Oblivia, large governments, especially in developing countries breed governmental discretion which in turn breeds corruption, if you think China needs a bigger more powerful government I would suggest you study the matter further.

Zac, I actually am living in Chile. Wages are in Pesos. But pretty much all debt, and often times rent, is in UF. Chile was stuck at the zero-lower bound for about 1 year (06/2009-06/2010). During this time there was about 1% deflation. By 2010 there was 3% inflation (Central Bank target) and by 2011 there was 4% and unemployment had sunk to 7% (the lowest level in the past decade (and possibly ever))

Scott, I think you are discounting the problems that deleveraging has on aggregate demand. Deflation is bad because of it leads to unemployment because of sticky wages, but it is also bad because it balloons the debt/income ratio, which makes people less likely to spend and invest, further decreasing demand. If debt is denominated in real terms, then deflation will lower debt in pace with income. Am I missing something? I’m probably missing something…

Mike, It’s sad that the press didn’t cover this story. I’m one of the few people to point out that the massive taxpayer bailouts went to the small banks, the big banks received loans which they repaid. Taxpayers will never get their money back from the reckless actions of the small banks.

Rob, Good points.

Hunter, You are missing the fact that debt problems come from falling NGDP (i.e. falling AD) not from deflation. If prices are falling at 1% and RGDP rises at 10% you are generally in pretty good shape.

Don’t think of deflation as a cause of lower AD, think of it as an effect.

“It wasn’t the big banks, it was the way FDIC encouraged small banks to make risky loans to developers.”

In addition to Mike, I was also intrigued by this assertion. When asked for further info, Scott replied:

“Mike, It’s sad that the press didn’t cover this story. I’m one of the few people to point out that the massive taxpayer bailouts went to the small banks, the big banks received loans which they repaid. Taxpayers will never get their money back from the reckless actions of the small banks.”

The reply doesn’t address at all the initial assertion that the FDIC “encouraged small banks to make risky loans to developers”.

Scott, this may be breaking news. I’m opened minded on this, but you need to come up with the goods.

Vivian, OK, I see the problem. I should have been clearer. The EXISTENCE of FDIC encouraged small banks to make risky loans to developers. Simple moral hazard. I didn’t mean to suggest they made verbal recommendations, as that wasn’t necessary.

Thank you for the clarification. However, I’m still puzzled. How did even the existence of the FDIC encourage these risky developer loans? Do you have any statistical evidence or other that these “developer loans” were the (primary) cause of the financial crisis? The FDIC insured *deposits* up to $250K. They are not, to my knowledge, in the business of guaranteeing loans.

This program allowed smaller banks to compete for large deposits that otherwise would go to larger banks, and also likely reduced the need for banks to compete based on safety/risk, since depositors no longer had to consider risk when making deposits.

The problem with the C20th development of the US financial system was not Glass-Steagall (1934), it was the McFadden Act (1927): local protectionism. If you are going to have deposit insurance, separating out banking functions is not such a bad idea. Limiting the ability of banks to pool regional risks–not such a good idea.

On regulation in China–rule of law would be a great idea. That is not quite the same as “more regulation”.

On small cities struggling–didn’t some guy get a Nobel prize for explaining why you get urban concentrations? China has lots of footloose labour (and capital) and falling transport (and communication) costs. So, the prediction would be … Struggling small cities.

One of the reasons why C19th US economic cycles were so pronounced was that finding out which industries would concentrate where added to asset booms and busts. Why would not a massively industrialising China go through broadly the same process? Especially given that which concentrations of what happen where is so “path dependent”.

“Mike, It’s sad that the press didn’t cover this story. I’m one of the few people to point out that the massive taxpayer bailouts went to the small banks, the big banks received loans which they repaid. Taxpayers will never get their money back from the reckless actions of the small banks.”

1. Are you referring to the Deposit Insurance Fund there? How is that funded again?

2. So the argument is that the firms that collapsed in the financial crisis received most of their funding through insured deposits rather than, say, repo?

3. And the argument is that mortgages losses held by small commercial banks is greater than the losses in PLS or CDOs?

I just want to get your theory into a null hypothesis here for testing.

“Mike, It’s sad that the press didn’t cover this story. I’m one of the few people to point out that the massive taxpayer bailouts went to the small banks, the big banks received loans which they repaid. Taxpayers will never get their money back from the reckless actions of the small banks.”

Again, Scott you need to back this up somehow. I’m interested in this story. If true, the entire explanation for the housing and financial crises needs to be re-written. Perhaps you could devote an entire column—expose if you will–on that subject? You would be doing not only the readers here a service, but the entire country.

Per the following source (as of mid-2011) the total amount of “bailouts” expended by the FDIC was about $8.9 billion. Is that what goes for “massive” these days? How does that compare with the bailouts of “large” banks by other federal agencies? How did the “existence” of the FDIC create this crisis?

The total amount expended by FDIC through deposit insurance to depositors has been about $93 billion since 2007. Is this a “bailout” of those small banks? And, who funds the FDIC insurance? Banks and indirectly depositors. That would be taking the term “taxpayer” a bit too far.

Vivian, Most of the bank failures covered by FDIC were due to defaults in loans to developers, not subprime mortgages. For many years, conservative economists have been warning that the moral hazard created by FDIC encouraged banks to make excessively risky loans. There’s a recent talk by Thomas Sargent, which I linked to, which discusses an old paper by Neil Wallace I believe.

Mike, Yes the losses borne by FDIC are ultimately paid by taxpayers. I don’t think that’s controversial. Your other two statements completely misrepresent what I said. I’m not talking about the cause of the financial crisis, I’m talking about the cause of the taxpayer bailouts to the banking system.

Vivian, If you believe that taxpayers don’t pay the gasoline tax, but rather gas stations absorb the gasoline tax, then your statement about FDIC makes sense. If you don’t believe that (and I hope you do not) then you might want to reconsider your views on the FDIC tax on bank deposits. I consider $100 billion to be a lot of money.

Also see my response to Mike. I’m not talking about the cause of the financial crisis. I’ve done many posts on the problem of the small banks.

“Both liberals and conservatives missed the real problem. It wasn’t the big banks, it was the way FDIC encouraged small banks to make risky loans to developers. The US taxpayers were saddled with the bill.”

Fascinating stuff! What / who can I read that has illustrated that point?

Actually the ghost cities feel a lot more like the S&L Crisis in the 1980s than our latest crisis. These cities are being built like office building in late 1980s Dallas and other cities and they do not have the short run ability to fill the vacancies. Therefore a lot smaller banks were bailed out by various government programs and we had a smaller but longer recession from 1990 to 1992. Over the long term this was an interruption in the economy although it lead to a lot of the consolidation of financial institutions.

Burying the lede aren’t we? There are one hundred and thirty-seven ghost cities in China???

Ordos will never be populated because the mines that would support it have closed. Now, that’s all well and good when private money makes bad bets. But involving the government creates a whole lotta moral hazard.

There’s an enormous surplus of wealth being created in China as they move from Maoism to crony capitalism, no doubt about that. OTOH, an astonishing amount of it is being wasted.

Collin, The S&L crisis of the early 1990s was a lot like the current crisis.

Benny, You might want to put “FDIC” in the search box, and then see how often it comes up. That should answer your question.

TallDave, You said;

“Ordos will never be populated because the mines that would support it have closed. Now, that’s all well and good when private money makes bad bets. But involving the government creates a whole lotta moral hazard.”

The properties in Ordos have been sold to private investors. And it’s not at all clear that Ordos will never be populated. But yes, there is a lot of waste in China, as you’d expect in a 1/2 communist country.

As far as 137 “ghost towns,” the press calls towns that are under construction “ghost towns” because they don’t have people living in them WHILE THEY ARE UNDER CONSTRUCTION.

There are many videos online of these ghost cities. It’s not because they are still under construction that they have no people living there. It’s not just apartments that sit vacant, it’s also skyscrapers, houses, government buildings, malls etc. The number one reason these ghost cities were made was to artifically boost GDP/economic numbers. Provinces around China are given numbers they have to meet. Officials in those provinces will do anything to get those numbers. The number two reason is officials don’t want Chinese to live in these brand new places to mess them up which is why prices stay high to keep out the riff raff. New cities are built next to old cities so you can see how the population maintains property. The old cities look run down and dirty even though all the buildings are only 20-50 years old. Weather is going to damage most of these buildings. At the South China Mall there are leaks in the roof, cracked floors and walls, broken windows, weeds, etc.

[…] Here’s a fairly sophisticated analysis of the ghost cities issue. It goes beyond the simplistic approaches taken by those on either side of the issue. It concludes that there might turn out to be ghost cities in some of China’s small cities, but that the larger cities will have plenty of people to use their infrastructure. It also draws an analogy between the ghost cities issue and the housing crisis in the U.S. […]

There are so many documentaries on empty cities in CHina – ‘If we build it they will come” It’s interesting to read a perspective that it is timing. With China’s population density I am really surprised if there was no one licing in these ghost cities.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.